Wednesday, June 29, 2011

There are two sides to the sale of an asset: a one-off payment to the seller and an expected stream of profits to the buyer. If the price is efficient, these two sides of the transaction should be equivalent: that is, the purchase price represents the net present value of the future stream of profits (i.e. the commercial value).

In general, in respect of sales of government assets the value of the business to the purchaser should exceed the commercial value of the asset if retained in Crown ownership because of the greater efficiencies likely to be achieved in private ownership. A competitive sale process should ensure that the value of those expected efficiency gains are captured by the Crown in the sale price. (see R. Kerr blog and www.treasury.govt.nz)

Saturday, June 18, 2011

In the months following September 11, 2001, Congress approved a fund to compensate the victims of the terrorist attacks on New York City and the Pentagon that claimed nearly 3,000 lives. Unlike most bills passed by Congress, this one had an unlimited budget. Money, in the grand scheme of things, was not an object when it came to the largest terrorist attack ever to occur on American soil.

But Congress wasn't about to open its checkbook indefinitely: It set tight criteria under which people could file a claim. With the stroke of a pen, Congress had put itself in the unenviable position of determining how much a human life is worth.

Kenneth Feinberg was appointed to manage the fund. Feinberg, a lawyer and former chief of staff to Senator Edward Kennedy, had been in this position before: In 1984, Feinberg negotiated a $180 million settlement paid by the manufacturers of Agent Orange to 250,000 Vietnam veterans who had been sickened by the chemical agent. He was part of the team that awarded $16 million to the Zapruder family for the 26.6-second film Abraham Zapruder took in Dallas on November 22, 1963, the day President John F. Kennedy was assassinated. In 2010, Feinberg was appointed to administer the $20 billion fund created by BP to compensate those affected by an oil spill in the Gulf of Mexico.

In the first case, Feinberg determined an average life was worth about $720 a head. Zapruder's family got about $600,000 per second of film. Along the Gulf of Mexico, the final payouts are yet to be determined. But why are the injuries to a Vietnam veteran worth only a fraction of a cent compared to a dollar's worth of a film? How much is a dead fish worth versus the life of an investment banker who would have made millions of dollars had her life not been cut short by a terrorist attack?

These are the questions at the heart of The Price of Everything: Solving the Mystery of Why We Pay What We Do. The author, Eduardo Porter, an editorial board member of TheNew York Times, leads readers on a leisurely, but thorough, trip through the corners of humanity in which price affects our decision-making process.

Much of Porter's book, despite its title, isn't dedicated to parsing the details of how commodity prices influence food or how comparison-shopping for plasma TVs keeps the market honest and prices low. Such matters are discussed in his very first chapter, "The Price of Things." The bulk of Porter's book is dedicated to more existential matters -- faith, "free," happiness, the future culture -- areas that, despite the ideals of purists, are no less subject to market forces than the device on which you read this review. Every examination isn't equally enlightening, but Porter is at his best when the subject is at its farthest from the traditional realm of economics.

The Price of Faith

Take, for example, Porter's discussion about the price of faith. The most starry-eyed of us would believe that faith is free, that the path between you and God is a toll-free highway with the only disruptions ones you place in your own path.

Think again: Even faith comes with a price tag, Porter argues. Religion demands sacrifices from its members, including dietary restrictions, sexual abstinence for the unmarried and tithing. You cannot just walk into St. Patrick's Cathedral and decide you are going to be a Catholic: You have to study, undergo several religious rites and demonstrate your allegiance to the faith. And that's just to get in the front door -- the pricing doesn't stop after your first Communion.

Porter takes the abstract subject of faith, breaks it down to its most elemental and applies price theory to its parts. Consider his analysis of why the normal laws of pricing seem to work in the inverse when it comes to the price of faith: "The most successful religions at building enthusiastic flocks are usually the most extreme in their beliefs, like evangelical Christians in the United States or radical Islamists in Central Asia and the Middle East. Even in the face of increasing opportunities in the secular world outside, these churches have developed a growing following of truly fervent believers by closing down their options. They select their members among people with the fewest opportunities outside and erect higher barriers to keep them in. It is a strange strategy: raising your prices to keep your customers. But it works."

The Price of a Life

Putting a price on life is no less abstract than faith, but it happens on a daily basis. How much, for example, would you pay for a car with the newest safety features versus a 10-year-old used car with a lesser generation of airbag? Although a host of other variables come into play -- the mileage of a used car, for example, or the cost of financing or even paint color -- all things being equal, Porter writes, the difference between the used car price and the new car could be construed as the price you are willing to pay for your safety, and ultimately, your life.

In determining how to mete out the bottomless pit of money allocated to the victims of September 11, Kenneth Feinberg was immediately faced with the challenge of putting a value on the tangible, and intangible, aspects of human existence. As Porter describes, Feinberg started with an arbitrarily flat figure of $250,000 a head plus $100,000 per dependent for the noneconomic loss of life. Figuring out how to compensate economic loss was more difficult.

The World Trade Center was home to a fleet of high-paid financial experts as well as a fleet of minimum-wage workers who kept the windows clean, the carpets vacuumed and the china at the Windows on the World restaurant clean. A busboy could never hope to earn as much in his life as a broker at Cantor Fitzgerald might earn in an above-average afternoon, but did that mean a broker's life was worth more than that of an illegal immigrant?

Although the fund paid $2 million, on average, to the next of kin to 2,880 victims who died in the attacks, "each of the families of the eight victims who earned more than $4 million a year got $6.4 million, while the cheapest victim was valued at more than $250,000," Porter wrote. Life, as it turns out, does indeed have its price tag.

The Price of Free

Porter's look at pricing also considers what he calls "the price of free," or the value of ideas and information -- an interesting discussion in light of TheNew York Times' recent implementation of a metered pay wall on its website. His book was published before the Times made its online pricing system public, but Porter, a media veteran, still has a lot to say about the concept of information floating around the Internet for free -- namely, that it's not.

Porter uses an apt analogy of a lighthouse to make his claim, writing, "Those who believe information online should be available at no cost like to see it as the light from a lighthouse. Any ship passing through the bay at night will benefit from its light, yet this use will not reduce the supply of light for other ships in the vicinity." It is a good analogy, because the theft of a copy of the latest blockbuster movie does not reduce the ability of others to view it, either online or at the local multiplex.

Of course, the light from the lighthouse isn't free. Nor is the news on CNN, nor clean air or national defense. The free rider problem, long ago identified with these public goods, has increased in the world of online information because the cost and availability of Internet access has dramatically fallen. If private companies can't make money providing information for free, they will abandon their efforts, as so many media organizations have done in the last decade.

Porter's meatiest work makes a thorough examination of the dynamics of how workers get paid and is the most relevant part of his book.

Take the history of determining the value of a single day's work. Nowadays, negotiating your own price is a common practice undertaken by millions of Americans. If you think you are worth more than your prospective employer wants to pay, you either negotiate for more money or turn the job down.

But in serfdom, and its first cousin, slavery, the price is totally set by the employer -- a situation that lends itself to some manageable labor costs, in theory. In practice, however, a company paying nothing for its labor does not mean a good deal. Porter writes, "Employers who could increase production by adding more inexpensive slaves had little incentive to invest in laborsaving technologies. Coerced workers had no incentive to become more productive -- because they would just be handing a higher surplus to the boss. Both these effects hindered economic progress."

Slaves were not free. The cost of buying, feeding and housing slaves, even in meager shanty towns, cut into the profits slave owners expected to reap. Slavery led to slower economic growth: The cost of free labor was too high.

When Prices Are Wrong

Published as the United States was only starting to crawl out of the deepest economic downturn in modern times, one that still held many European countries firmly in its grasp in 2011, Porter saves his biggest punches for his book's finale. After setting up situation after situation in which pricing is a way, if not the best way, to organize life, the first nine chapters of his book become target practice for the epilogue -- where pricing homes destroys the American economy and where economists have to derive a new theory to explain situations where the laws of pricing fail.

The theory of pricing, Porter writes, only works when relative prices are right. "When prices are wrong, these decisions are distorted, often to devastating effect. This, unfortunately, happens depressingly often," as it did between 2000 and 2006 when housing prices were boosted by 70% on average, on the belief that home prices would rise forever. During the so-called "dot-com" bubble of the late 1990s and early 2000s, any company with an "e" prefix was instantly assumed to be worth more -- an assumption that ultimately proved false after a wave of Internet companies filed for bankruptcy.

Economics must include human irrationality to be a more exact science, he argues, a paradox that lies at the heart of Porter's book. It must incorporate social norms, the pursuit of what people think they want, and individuals who will pay an exorbitant price for a seemingly meaningless object just because it's expensive. "Including all these dimensions of humanity is likely to turn economics into a messier, less mathematically elegant discipline" he writes -- an understatement for the ages -- "but, in exchange, the new economics will provide a more comprehensive understanding of the world. Also important, it will be able to grapple with the many ways in which the decisions we make based on the prices arrayed before us can take us in directions that, individually or as a society, we would rather avoid."

Porter skillfully blends economics and existentialism in his discussions of how prices are negotiated, which rescues the book's brisk 304 pages from being just another economic tome that tells readers why Starbucks charges four dollars for a venti latte or how Wal-Mart can undercut its competitors on nearly everything, from tires to lettuce. Although those topics are touched upon here, they have been so well covered elsewhere that Porter's decision not to ground his book in the everyday is far from fatal. In fact, as Porter himself could argue, they make the book worth its price.

Thursday, June 16, 2011

Have you ever tried to hire an average teenager? A few years ago, when I needed some furniture moved, my mother reached out to some fundraising teenagers on my behalf, offering the wage that I had set. The three boys eagerly accepted the offer, showed up for work and proceeded to demonstrate why it can be so difficult for many teenagers to land and maintain employment. They not only lacked experience, but they required detailed tutoring in seemingly straightforward work. More time was spent teaching them how to lift, move and pack furniture than they actually spent working.

In Oregon, you cannot legally employ anyone, teen or otherwise, for less than $8.50 per hour, even if his actual labor is worth much less. It should be little surprise then, that our population’s least experienced workers – teenagers – had an unemployment rate of 28.8 percent last year (much higher than the state’s rate of 10.2 percent). The national teen employment rate in 2010 was a meager 27 percent, which has dropped substantially since 2000, when it was healthier (but still too low) at 45%.

Tuesday, June 7, 2011

Art Carden writing in Forbes (May 13 2011) magazine expresses the answer to this question – such a critical question in N.Z. right now – very well:

Someone once asked me why economists care so much about the minimum wage. It reduces employment for the poor, to be sure, but the efficiency effects are probably pretty small compared to the effects of other policies. So why do economists care so much about the minimum wage when there are other policies that inflict greater damage?

It’s a good question, and an important one. The welfare loss might be small–though this is itself debatable–but the relevance of economic thinking is what is important. Beyond its consequences for the poor, I care about the minimum wage because it brings into high relief the fundamental differences between the anti-economic way of thinking and the economic way of thinking.

The anti-economic way of thinking sees the minimum wage as a policy whereby those endowed with Goodness and Mercy redistribute possibly ill-gotten wealth from the rich to the poor and protect the weak from exploitation. According to this view, the only reasons to oppose the minimum wage are ideology and sheer meanness. Just as the only reason someone could possibly oppose a war is because he or she hates America, the only reason someone could possibly oppose the minimum wage is that he or she hates poor people. Or so some might think. The economic way of thinking sees the minimum wage as exactly what it is: interference that destroys wealth, encourages wasteful rent seeking, and hurts exactly the people it is alleged to help.

The “anti-economic way of thinking sometimes seems to thrive in N.Z….. and we all suffer when it does (thanks to NZBR for the alert).

Sunday, June 5, 2011

The whole story is here. Here is what kicked it off. Needless to say it fits the Adam Smith warning

I have never known much good done by those who affected to trade for the public good

Philips created its L.E.D. bulb to compete for the L Prize, a government-sponsored award meant to encourage the development of a replacement for the 60-watt incandescent before the new standards begin to go into effect in January. Traditional incandescents are extremely inefficient, giving off 90 percent of their energy as heat, not light, and over the years, the government and the lighting industry tried to move consumers on to products like halogens and compact fluorescents. But no amount of subsidy or “green” branding has managed to woo consumers away from Edison’s bulb. “Not only is it in alignment with the type of light that consumers like,” says David DiLaura, author of “A History of Light and Lighting.” “It’s commoditized and it’s cheap.”

So some years ago, Philips formed a coalition with environmental groups including the Natural Resources Defense Council to push for higher standards. “We felt that we needed to make a call, and show that the best-known lighting technology, the incandescent light bulb, is at the end of its lifetime,” says Harry Verhaar, the company’s head of strategic sustainability initiatives. Philips told its environmental allies it was well positioned to capitalize on the transition to new technologies and wanted to get ahead of an efficiency movement that was gaining momentum abroad and in states like California. Other manufacturers were more wary, but they also understood the downside to selling a ubiquitous commodity: the profit margin on a bulb that sells for a quarter is negligible. After much negotiation, the industry and environmental groups agreed to endorse tightening efficiency by 25 to 30 percent.